In the early days of the COVID-19 pandemic, lawmakers enacted the CARES Act to provide some relief to the ailing economy. One of its provisions, meant to encourage charitable giving, temporarily suspended limits on tax deductions for certain charitable gifts made in 2020.
More recently, the Consolidated Appropriations Act (CAA) extended this relief to charitable gifts made in 2021. The CARES Act also created a temporary charitable deduction for non-itemizers, which was extended through 2021 (and expanded) by the CAA. (See “Above-the-line charitable deduction for non-itemizers.”)
If you’re willing and able to make charitable donations, be sure to study the tax implications carefully. Unlimited charitable deductions — which theoretically enable you to reduce your 2021 tax bill to zero — may be appealing, but for some people a more measured approach can lead to more favorable tax results.
Ordinarily, if you itemize, you’re permitted to deduct charitable gifts up to a specified percentage of your adjusted gross income (AGI). Excess gifts may be carried forward and deducted (subject to applicable limits) for up to five years.
The AGI percentage varies depending on the type of assets donated and the type of charitable organization that receives them. For example, cash donations to religious organizations, educational institutions, donor-advised funds, supporting organizations and other public charities are generally limited to 50% of AGI, while gifts of capital gain property, such as appreciated stock or real estate, are generally limited to 30% of AGI.
The deduction limits for gifts of cash and capital gain property to private foundations are 30% and 20% of AGI, respectively. The Tax Cuts and Jobs Act increased the limit for cash gifts to public charities to 60% for gifts made through 2025.
For gifts made in 2020, the CARES Act gave taxpayers the option of deducting “qualified charitable contributions” up to 100% of AGI, and the CAA extended the 100% limit to gifts made through the end of 2021. Qualified charitable contributions generally include cash gifts to public charities other than donor-advised funds or supporting organizations.
If you have the resources and the desire to make substantial charitable gifts, in theory, you can make a qualified charitable contribution large enough to offset all of your taxable income in 2021 and reduce your tax bill to zero. That may be an enticing proposition, but it’s not the most effective way to generate tax savings.
The reason being is because when you use charitable gifts to reduce your taxable income to zero, a portion of those gifts offset income that would otherwise have been taxed at low rates, essentially diminishing their tax-saving power. In most cases, you’re better off preserving a portion of these deductions for future years, when they can be offset against higher-taxed income.
Consider this example: Ben and Geri, a married couple in their late 50s with taxable income of $450,000 per year, wish to make a $450,000 cash donation to a local hospital. Without the charitable deduction, they would be in the 35% tax bracket, with a tax bill of $106,589. So, if they donate $450,000, they’ll save $106,589 in taxes.
Another approach would be for Ben and Geri to donate enough to bring their tax bracket down to 12%. This year, the top end of that bracket is $81,050, so that would mean donating $368,950 this year and the remaining $81,050 next year.
Presuming for illustrative purposes that a) this is the only charitable contribution that they’re considering, b) their deductions other than the charitable contributions would allow them to itemize, and c) the 2021 tax rates are used for the 2022 calculations, the couple’s tax bill is $9,328 in 2021 and $79,718 in 2022, for a total tax savings of $124,132 (a $97,261 tax reduction in 2021 ($106,589 – $9,328) and a $26,871 tax reduction in 2022 ($106,589 – $79,718.)
What if it’s important to Ben and Geri to donate the full $450,000 this year? In that case, they could simply elect not to treat the gift as a qualified charitable contribution. The normal limits, 60% of their adjusted gross income, would apply, meaning that any amount that went unused this year would be carried forward to next year. Presuming their tax picture — other than the charitable contribution — is the same in both years, their total tax savings over the two years would be $128,941.
If you’re thinking about taking advantage of 100% of AGI charitable deductions, be sure to do the math and determine whether there are more tax-efficient options. As the above example illustrates, most people are better off spreading out charitable deductions over two or more years. With the possible exception of taxpayers with income well into seven figures, offsetting all of your income in one year usually isn’t the best strategy.
Charitable deductions are usually available only to those who itemize deductions, but the CARES Act provided non-itemizers with an above-the-line deduction — that is, a deduction from gross income in arriving at adjusted gross income — of up to $300 for cash gifts to public charities other than donor-advised funds or supporting organizations. The act was ambiguous as to whether joint filers were entitled to a $600 deduction, but the Form 1040 instructions for 2020 made clear that the deduction limit was $300 for both individuals and joint filers.
The Consolidated Appropriations Act extended the deduction for non-itemizers through 2021. It also provided that joint filers who don’t itemize are entitled to deduct up to $600 in eligible charitable gifts.
© 2021